An IOU (I Owe You) is a legal document that sets out the details of a loan made between two people, a borrower, and a lender. The note clearly outlines the borrower’s promise to repay the lender within a specified time fully.
It includes all the terms and conditions of the loan transaction and ensures the parties have a thorough and complete written record of the deal and their intentions.
The note should be finalized before any money changes hands.
IOU vs. Promissory Note vs. Loan Agreement
An IOU is similar to a promissory note and a loan agreement because it’s an agreement to pay back money owed. However, it is usually not a negotiable instrument and does not contain details about repayment and the consequences of not repaying.
We’ve created a simple table below explaining the three documents’ differences.
| Aspect | IOU | Promissory Note | Loan Agreement |
|---|---|---|---|
| Complexity | The most informal and least complex of the three. | It's more formal and complex than an IOU but less formal and complex than a loan agreement. | The most formal and complex of the three. |
| Content | It describes the amount owed and includes the borrower's signature. It may have other elements depending on the parties' attention to detail. | It typically includes the borrowed sum, interest rate, repayment date, and the borrower's signature. | In addition to the details in a promissory note, a loan agreement also contains information about the collateral (if applicable), default terms, and other legal provisions. |
| Legal Enforceability | It's the most challenging to enforce in court because of its ambiguity. | It's typically enforceable in court. | It's the easiest to enforce in court because of its detailed nature. |
| Use Cases | It's most common for individuals to use this document when loaning small sums to family and friends. | Individuals can use this document for business or personal loans. | Individuals and businesses use this document for mortgages or other more complex loan arrangements that involve larger sums of borrowed money. |
When Do You Need an IOU?
An IOU allows both parties to record the amount of money borrowed and clarify when the borrower should repay the loan.
The document is often used with family, friends, and even colleagues and can remind the parties involved of the loan details.
Here are some everyday situations when you might need this document:
- You have done business with someone in the past and are willing to take an IOU
- You do not have enough for an item, so you give an IOU for the remaining amount
- You want to borrow money for a down payment for an event like a wedding or party
IOUs are very informal loan agreements. If you want to lend money to a friend or family member and enjoy a more formal contract, consider creating a promissory note or loan agreement.
What Happens If I Don’t Use an IOU?
If you’re loaning money to a person and don’t draft any written agreement, you are effectively creating a verbal agreement, otherwise known as an oral contract.
While verbal contracts are legally binding, there can be great difficulty enforcing such agreements in court.
Just like a written contract, verbal contracts need to have some aspects for them to be legal:
-
An offer and acceptance
- One party must present an offer to the other party, and there must be a mutual acceptance of terms in the verbal agreement.
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Lawful purpose
- The reason for the contract must be legal. Parties cannot engage in illegal activities.
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Lawful consideration
- The exchange of value (e.g., money) must be legal. Exchanges cannot be made with illegal means, such as using drugs as a substitute for money.
-
Certainty and completeness of terms
- The terms of the verbal contract must be clear. There can be no room for misinterpretation or vague language, as both parties must understand their obligations in the agreement.
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Free consent of the parties
- The parties in the agreement must enter it willingly, without coercion or undue influence. There can also be no falsities leading to a party entering the agreement under pretenses.
-
Capacity
- Parties must be above the age of majority and of sound mind.
If the verbal agreement doesn’t have all of these elements, the court will not enforce the contract.
Another significant issue is that a person can refuse to pay back the loan, and even if you take them to small claims court, they can claim they didn’t agree to anything in the first place.
To help your case, you would need evidence to prove that an agreement was made. When people owe you money, having a written contract like an IOU to present in court as evidence would be helpful.
You can look at the table below to see more consequences for not using an IOU.
| Lender | Borrower |
|---|---|
| Unable to enforce a verbal promise | Unpaid expenses |
| Expensive lawyer fees to: 1. defend undocumented promise to pay 2. recover money unpaid | Expensive lawyer fees to: 1. demand undocumented promised money 2. pursue money promised |
| Loss of friendship or family trust | Loss of friendship or family trust |
| Personal safety & wellbeing | Personal safety & wellbeing |
